What’s the rationale here? Because of high IB?
IB?
I think it’s because the increase in tracking error is more than offset by the increase in (expected) alpha.
because tracking risk is lower than with full active management
But alpha is lower as well?
Its a RELATIVE comparison of active return to active risk.
increaseing active return will cause the std dev of active return to increase at a greater ratio than 1 for 1, so when looking at IR only, active indexing will be superior even though full blown active management will produce a higher alpha
No, it’s just not exponentially increased - it couldbe a linear increase in alpha with tracking risk and would still decrease the IR (Think alpha is at 2 with active ret at 1 and tracking risk at 0.5, increase alpha to 1.5/1 and you have less than two).
Tracking Risk = annualized S.D of active returns
Let’s say tracking risk double. However, alpha will below double. Any formula can explain that or it’s just by historical observation?